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Here's Why Hebei Construction Group (HKG:1727) Can Manage Its Debt Responsibly

Simply Wall St

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that Hebei Construction Group Corporation Limited (HKG:1727) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Hebei Construction Group

How Much Debt Does Hebei Construction Group Carry?

As you can see below, Hebei Construction Group had CN¥3.48b of debt, at December 2018, which is about the same the year before. You can click the chart for greater detail. But on the other hand it also has CN¥9.13b in cash, leading to a CN¥5.65b net cash position.

SEHK:1727 Historical Debt, September 2nd 2019

How Healthy Is Hebei Construction Group's Balance Sheet?

According to the last reported balance sheet, Hebei Construction Group had liabilities of CN¥53.7b due within 12 months, and liabilities of CN¥1.37b due beyond 12 months. Offsetting these obligations, it had cash of CN¥9.13b as well as receivables valued at CN¥44.1b due within 12 months. So it has liabilities totalling CN¥1.83b more than its cash and near-term receivables, combined.

Hebei Construction Group has a market capitalization of CN¥8.65b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt. While it does have liabilities worth noting, Hebei Construction Group also has more cash than debt, so we're pretty confident it can manage its debt safely.

Also good is that Hebei Construction Group grew its EBIT at 19% over the last year, further increasing its ability to manage debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Hebei Construction Group's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Hebei Construction Group may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Looking at the most recent three years, Hebei Construction Group recorded free cash flow of 43% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing up

While Hebei Construction Group does have more liabilities than liquid assets, it also has net cash of CN¥5.7b. And we liked the look of last year's 19% year-on-year EBIT growth. So we are not troubled with Hebei Construction Group's debt use. We'd be motivated to research the stock further if we found out that Hebei Construction Group insiders have bought shares recently. If you would too, then you're in luck, since today we're sharing our list of reported insider transactions for free.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.